LIABILITIES

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Chapter10
LIABILITIES
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The Nature of Liabilities
Defined as debts or obligations arising from past
transactions or events.
Maturity 1 year or less
Maturity gt 1 year
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Notes Payable
When a company borrows money, a note payable is
created. Current Portion of Notes Payable The
portion of a note payable that is due within one
year, or one operating cycle, whichever is longer.
Total Notes Payable
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Notes Payable
PROMISSORY NOTE Location Date
after this date
promises to pay to the order of the sum of
with interest
at the rate of per annum.

signed title
Miami, Fl
Nov. 1, 2007
Porter Company
Six months
Security National Bank
10,000.00
12.0
John Caldwell
treasurer
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Notes Payable
On November 1, 2007, Porter Company would make
the following entry after issuing the note.
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Interest Payable

• Interest expense is the compensation to the
  lender for giving up the use of money for a
  period of time.
• The liability is called interest payable.
• To the lender, interest is a revenue.
• To the borrower, interest is an expense.

Interest Rate Up!
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Interest Payable

• The interest formula includes three variables
  that must be considered when computing interest

Interest Principal Interest Rate Time
When computing interest for one year, Time
equals 1. When the computation period is less
than one year, then Time is a fraction.
For example, if we needed to compute interest for
3 months, Time would be 3/12.
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Interest Payable Example
What entry would Porter Company make on December
31, the fiscal year-end?
10,000???12 ??2/12 200
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Interest Payable Example
Porter will pay the note on January 31, 2008.
Lets look at the entry.
10,000???12 ??1/12 100
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Payroll Liabilities
Gross Pay
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Unearned Revenue
Cash is sometimes collected from the customer
before the revenue is actually earned.
As the earnings process is completed . .
a liability account.
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Long-Term Liabilities
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Long-Term Liabilities
Large debt needs are often filled by issuing
bonds.
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Installment Notes Payable
Long-term notes that call for a series of
installment payments.
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Allocating Installment Payments Between Interest
and Principal

• Identify the unpaid principal balance.
• Interest expense Unpaid Principal Interest
  rate.
• Reduction in unpaid principal balance
  Installment payment Interest expense.
• Compute new unpaid principal balance.

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Allocating Installment Payments Between Interest
and Principal
On January 1, 2007, Rocket Corp. borrowed
7,581.57 from First Bank of River City. The
loan was a five-year loan and had an interest
rate of 10. The annual payment is
2,000. Prepare an amortization table for Rocket
Corp.s loan.
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Allocating Installment Payments Between Interest
and Principal
Now, prepare the entry for the first payment on
December 31, 2007.
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Allocating Installment Payments Between Interest
and Principal
The information needed for the journal entry can
be found on the amortization table. The payment
amount, the interest expense, and the amount to
debit to principal are all on the table.
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Bonds Payable

• Bonds usually involve the borrowing of a large
  sum of money, called principal.
• The principal is usually paid back as a lump sum
  at the end of the bond period.
• Individual bonds are often denominated with a par
  value, or face value, of 1,000.

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Bonds Payable

• Bonds usually carry a stated rate of interest,
  also called a contract rate.
• Interest is normally paid semiannually.
• Interest is computed as

Interest Principal Stated Rate Time
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Bonds Payable

• Bonds are issued through an intermediary called
  an underwriter.
• Bonds can be sold on organized securities
  exchanges.
• Bond prices are usually quoted as a percentage of
  the face amount.
• For example, a 1,000 bond priced at 102 would
  sell for 1,020.

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Types of Bonds
Mortgage Bonds
Debenture Bonds
Convertible Bonds
Junk Bonds
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Accounting for Bonds Payable
On January 1, 2007, Rocket Corp. issues
1,500,000 of 12, 10-year bonds payable.
Interest is payable semiannually, each July 1 and
January 1. Assume the bonds are issued at face
value.Record the issuance of the bonds.
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Accounting for Bonds Payable
Record the interest paymenton July 1, 2007.
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Bonds Sold Between Interest Dates

• Bonds are often sold between interest dates.
• The selling price of the bond is computed as

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The Present Value Concept and Bond Prices

• The selling price of the bond is determined by
  the market basedon the time value of money.

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Bonds Issued at a Discount
Matrix, Inc. is attempting to issue 1,000,000
principal amount of 9 bonds. The bonds pay
interest on June 30 and December 31 each year and
mature in 20 years. Investors are unwilling to
pay the full face amount for Matrixs bonds
because they believe the interest rate is too
low. To entice investors, Matrix must lower the
price of the bonds. The difference between the
new lower issue price and the principal of
1,000,000 is called a discount. Lets see how we
account for these bonds.
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Bonds Issued at a Discount
Matrix, Inc. issues bonds on January 1,
2007. Principal 1,000,000 Issue price
950,000 Stated Interest Rate 9 Interest
Dates 6/30 and 12/31 Maturity Date Dec. 31,
2026 (20 years)
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Bonds Issued at a Discount
To record the bond issue, Matrix, Inc. wouldmake
the following entry on January 1, 2007
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Bonds Issued at a Discount
Maturity Value
Carrying Value
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Bonds Issued at a Discount
Amortizing the discount over the term of the bond
increases Interest Expense each interest payment
period.
Using the straight-line method, the discount
amortization will be 1,250 every six months.
50,000 40 periods 1,250
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Amortization of the Discount
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Bonds Issued at a Discount
50,000 1,250 1,250
Maturity Value
Carrying Value
The carrying value willincrease to exactly
1,000,000on the maturity date.
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Bonds Issued at a Discount
To record the principal repayment, Matrix,
Incwould make the following entry on December
31, 2026
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Bonds Issued at a Premium
If bonds of other companies are yielding less
than9 percent, investors will be willing to pay
more thanthe face amount for Matrixs 9 bonds.
The issueprice of Matrixs 9 bonds will rise
because ofinvestor demand for the 9 bonds.
Thedifference between the higher issue price and
theprincipal of 1,000,000 is called a
premium. Lets look at accounting for a premium.
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Bonds Issued at a Premium
Matrix, Inc. issues bonds on January 1,
2007. Principal 1,000,000 Issue price
1,050,000 Stated Interest Rate 9 Interest
Dates 6/30 and 12/31 Maturity Date Dec. 31,
2026 (20 years)
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Bonds Issued at a Premium
To record the bond issue, Matrix, Inc. wouldmake
the following entry on January 1, 2007
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Bonds Issued at a Premium
Maturity Value
Carrying Value
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Bonds Issued at a Premium
Amortizing the premium over the term of the bond
decreases Interest Expense each interest payment
period.
Using the straight-line method, the premium
amortization will be 1,250 every six months.
50,000 40 periods 1,250
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Bonds Issued at a Premium
To record an interest payment, Matrix, Inc. would
makethe following entry on each June 30 and
December 31
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Bonds Issued at a Premium
Maturity Value
Carrying Value
The carrying value willdecrease to exactly
1,000,000on the maturity date.
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Bonds Issued at a Premium
To record an the principal repayment, Matrix
would makethe following entry on December 31,
2026
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The Concept of Present Value
Present Value
Future Value
Money can grow over time, because it can earn
interest.
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The Concept of Present Value

• How much is a future amount worth today?

Present Value
FutureValue
Interest compounding periods
Today
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The Concept of Present Value

• How much is a future amount worth today?
• Three pieces of information must be known to
  solve a present value problem
• The future amount.
• The interest rate (i).
• The number of periods (n) the amount will be
  invested.

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The Concept of Present Value
Two types of cash flows are involved with bonds
Periodic interest payments called annuities.
Today
Maturity

• Principal payment at maturity.

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Early Retirement of Debt

• Gains or losses incurred as a result of retiring
  bonds should be reported as other income or other
  expense on the income statement.

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Evaluating the Safetyof Creditors Claims
This ratio indicates a margin of protection for
creditors.
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Liabilities Question
Devon Mfg. reports annual operating income of
100,000 and annual interest expense of
10,000. What is Devons interest coverage ratio?
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Lease Payment Obligations
Operating Leases
Capital Leases
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Capital Lease Criteria